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Mexican Peso Outlook: Improved Risk-Appetite Hammers USD/MXN as EMFX Gains Ground

Mexican Peso Outlook: Improved Risk-Appetite Hammers USD/MXN as EMFX Gains Ground

Diego Colman,
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  • USD/MXN has plummeted towards critical technical support following the recent pull-back
  • The fundamental backdrop is becoming more constructive for the Mexican peso
  • U.S. bond market dynamics and global risk sentiment will be the main drivers for EMFX in the near term

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After briefly hitting a six-month high near 20.90 last week, USD/MXN has embarked on a major pullback, erasing most of its rally since late September, dragged down by a rebound in risk appetite.

In the U.S., fears of stagflation caused by runaway energy prices and supply chain snags had weighed on sentiment, but the start of the quarterly earnings season had helped to quell excessive pessimism, as corporate profits and forward-looking forecasts remain healthy by a wide margin, even with many economic challenges on the horizon.

Reduced market anxiety has paved the way for a solid bounce in U.S. equities, with the S&P 500 and Nasdaq 100 up nearly ~6% and ~7% respectively from their monthly lows, despite some concerns about the Fed's policy normalization roadmap.

When things are going well on Wall Street, EMFX tends to do fine as traders look for riskier assets with greater upside potential. That said, if U.S. stocks continue to perform well in the near-term and the transition to higher rates in the Treasury curve becomes more orderly, the Mexican peso stands in a good position to gain ground against the U.S. dollar.

In the low-yield environment we currently live in, akey advantage enjoyed by MXN is its high carry, recently boosted by Banxico’s tightening cycle. The Mexican central bank has raised borrowing costs three times in 2021 and may do sotwice more before the end of the year to tackle mounting inflationary pressures. When it is all said and done, the overnight rate may end the year at 5.25%, widening the spread with the Fed’s benchmark rate.

Another catalyst to consider is the strength of oil, a key export for the Mexican economy. Elevated prices for this commodity should bolsterrevenues for state-owned Pemex, alleviating fiscal pressures and reducing the possibility of a sovereign credit downgrade, a perennial threat for the government.

Overall, there are reasons to be optimistic about the Mexican peso's prospects, but traders should continue to monitor bond market dynamics and general sentiment, as these two variables may be more important for the currency market in the near term.

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In the last few days, USD/MXN has plummeted towards cluster support in the 20.20/20.15 area. If bears manage to push price below this floor, selling momentum could accelerate in the coming sessions, paving the way for a move towards the 19.85/19.80 region.

On the other hands, if buyers retake control of the market and price resumes its ascent, the first resistance to consider appears at 20.45, a technical barrier defined by the August high. Should USD/MXN clear this hurdle, it would not be surprising to see a rally towards the October high at 20.90.

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Source: TradingView


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---Written by Diego Colman, Contributor

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.